This country-specific Q&A provides an overview to tax laws and regulations that may occur in United States.
This Q&A is part of the global guide to Private Client. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/practice-areas/private-client-2nd-edition/
Which factors bring an individual within the scope of tax on income and capital gains?
An individual is considered a ‘US Person’, and therefore subject to income tax on worldwide income and capital gains, if the individual is a US citizen (regardless of physical residency) or is a Lawful Permanent Resident (i.e., a ‘green card’ holder) or meets the ‘substantial presence test’, determined by the following formula: days (including partial) present in the US in the current tax year (which must be at least 31), plus days present in the prior tax year divided by 3, plus days present in the US in the second year before the current year divided by 6. If the sum of this calculation equals or exceeds 183, then the person is a US Person for the current tax year. An individual can be present in the US for up to 182 days in the current tax year without becoming a US Person if the individual has a documented closer connection to a foreign country. A nonresident is generally subject to US income tax only on (1) income from the sale of US real property, (2) income from a US trade or business, and (3) most interest, dividend, rental and royalty income from US sources. Interest on US bank deposits is not subject to income tax for nonresidents. Income tax treaties entered into between the US and certain countries can ameliorate the effect of any such taxes for nonresidents.
What are the taxes and rates of tax to which an individual is subject in respect of income and capital gains and, in relation to those taxes, when does the tax year start and end, and when must tax returns be submitted and tax paid?
a. Individual Ordinary Income Tax Rates. There are four filing statuses and seven brackets for individual federal ordinary income tax; the brackets are indexed for inflation. The following table shows the anticipated individual income tax rates and brackets for the 2019 tax year.
Married filing Jointly and Surviving Spouses
Married Filing Separately
Head of Household
b. Capital Gains Rates. For individual taxpayers (i.e., US Persons and nonresidents with US source income), the capital gains rate depends on the individual’s tax bracket, and whether the gains are classified as short-term capital gains or long-term capital gains. Short-term capital gains are gains from the sale or disposal of assets held for one year or less. Individuals pay short-term capital gains at the same rate as their ordinary income tax rate. Long-term capital gains are gains from the sale or disposal of assets held for more than 12 months and they are taxed at 0%, 15% or 20% depending on an individual’s income tax bracket. Long-term capital gains on the sale of collectibles (such as works of art or other tangible personal property) are taxed at 28%. If long-term capital gains raise an individual’s income from one bracket to another, only the portion that is in the higher bracket – not the entire gain – is taxed at the higher rate. It is possible to defer the realization of capital gains on the sale of investment real property by investors through the use of a like-kind exchange of similar investment real property. As a result of the 2017 enactment of the Tax Cuts and Jobs Act (described in the answer to question 28) and the issuance of proposed Treasury regulations, deferral of such gains on the sale of capital assets other than investment real property is unavailable, except to the extent the proceeds of sale are invested in a qualified business or property located within a special “qualified opportunity zone” (i.e., generally, a listed disadvantaged area within the US) for a fixed period of time.
c. Social Security and Medicare Taxes. US Persons who work as employees and nonresidents with US-source salaried income are obligated to pay a social security tax at a rate of 6.2% on compensation up to $132,900, and a Medicare tax at a rate of 1.45% on compensation up to certain thresholds ($125,000 for married taxpayers who file separately, $250,000 for married taxpayers who file jointly, and $200,000 for single and all other taxpayers) and 2.35% on compensation in excess of these thresholds. (These figures are adjusted annually for inflation.) Self-employed US Persons and nonresidents with US-source self-employment income must pay 12.4% of their annual self-employment earnings up to $132,900 toward social security taxes, as well as 2.9% of their self-employment earnings up to the above thresholds and 3.8% of their earnings in excess of these thresholds, toward Medicare taxes.
d. Length of Tax Year; Tax Return Submission; Payment of Tax. The tax year for individuals runs from January 1 to December 31. Individuals are required to file income tax returns reporting their income and capital gains, and pay any tax due, by April 15 of the year following the end of the taxable year to which the return relates. Individuals who cannot file by the due date for their return may request an extension of time to file. An extension of time to file is not an extension of time to pay, however, and individuals may be subject to a late payment penalty on any tax not paid by the original due date of their return.
Are withholding taxes relevant to individuals and, if so, how, in what circumstances and at what rates do they apply?
Withholding is required for US Persons and nonresidents on all salary income earned in the US. There is no set withholding rate, but generally withholding must be sufficient to cover 90% of income tax for the year to avoid an interest charge. Self-employed individuals and salaried individuals with other non-salaried income (such as bank interest, dividends, royalties, etc) are not required to withhold income taxes on such income, but must pay estimated taxes on a roughly quarterly basis. For nonresidents, there is a 30% withholding (15% under certain tax treaties) on most US-source interest, dividends, rental and royalty income. Interest on bank deposits is not subject to withholding.
Is there a wealth tax and, if so, which factors bring an individual within the scope of that tax, at what rate or rates is it charged, and when must tax returns be submitted and tax paid?
The US does not impose a federal wealth tax.
Is tax charged on death or on gifts by individuals and, if so, which factors cause the tax to apply, when must a tax return be submitted, and at what rate, by whom and when must the tax be paid?
The US transfer tax system is three pronged: a gift tax applies to certain transfers made during lifetime; an estate tax applies to certain transfers taking effect at death; and a generation-skipping transfer tax (GST tax) is imposed on certain transfers made during lifetime or at death (or at the time of distribution in the case of a transfer from a trust) to a person (a skip person) more than one generation below the transferor. Some, but not all, states within the US also impose estate or inheritance taxes.
The US imposes a gift tax on donative transfers from a US citizen or domiciliary to donees other than a US citizen spouse or charity, except with respect to certain transfers for a donee’s education or healthcare. US gift tax is imposed on a flat 40% rate on cumulative taxable gifts (other than annual exclusion gifts) in excess of the basic exclusion (gift tax exemption) amount of $10,000,000, as adjusted annually for inflation from 2010 ($11,400,000 in 2019). Annual exclusion gifts are gifts of a present interest from a US citizen or domiciliary to a donee other than a US citizen spouse or charity that do not exceed $15,000 (for 2019) per donee (or $30,000 per donee (for 2019) if made by a married donor whose spouse consents on a US gift tax return to having such gifts treated as having come one-half from him or her). Gifts to a spouse who is not a US citizen that do not exceed $155,000 (for 2019) qualify for the annual gift tax exclusion. Outright gifts are considered gifts of a present interest. Gifts made in trust may be gifts of a present interest if certain withdrawal powers or termination provisions are present in the trust; the absence of such entitlements will cause a gift made in trust to not qualify as an annual exclusion gift. Reporting of taxable gifts and the payment of any US gift tax due thereon must be made by April 15 of the year following the year in which the taxable gift was made (with extensions available upon request).
The US imposes an estate tax on the taxable estate of a US citizen or domiciliary. A US citizen’s or domiciliary’s taxable estate consists of his or her worldwide gross estate, valued as of date of death (or the earlier of the date of disposal of the assets or the date that is six months after the date of death, if the effect of choosing this ‘alternate valuation date’ will be a lowering of the estate tax due), reduced by various deductions (such as debts, administration expenses, qualified distributions made to or for the benefit of a surviving US citizen spouse or charity) and credits. US estate tax is imposed at a flat 40% rate on a taxable estate above the basic exclusion (estate tax exemption) amount of $10,000,000, as adjusted annually for inflation from 2010 ($11,400,000 in 2019), after reduction therefrom of taxable gifts made during lifetime. Nonresidents are also subject to US estate tax on US-situs property owned at death. US-situs property of a nonresident includes real or tangible personal property with a physical location within the US, shares of stock of a US corporation, certain debt obligations, deferred compensation of a US Person, and annuity contracts of a US obligor. Bank deposits and life insurance are not considered US-situs property of a nonresident. The taxable estate of a nonresident is taxed at a progressive estate tax rate capped at 40%, but the estate is allowed an estate tax exemption of only $60,000. US estate tax is due 9 months from date of death, although an extension of time to pay may be granted for reasonable cause. Likewise, for gross estates that exceed the estate tax exemption amount, a US estate tax return is due 9 months from date of death; an automatic 6-month extension of time to file is available. No further extension is available beyond 15 months from date of death. Under the concept of portability, for a married decedent who has not exhausted his or her available estate tax exemption, the filing of an estate tax return allows the porting of the deceased spouse’s unused exemption to the surviving spouse to avoid wastage of the predeceased spouse’s estate tax exemption. Portability is not available with respect to unused GST exemption.
The US imposes a GST tax on (1) outright transfers to skip persons (including trusts where all of the beneficiaries are skip persons), (2) distributions from certain trusts to skip person, and (3) on the assets of a trust where all of the remaining beneficiaries are skip persons upon the death of the last beneficiary who is not a skip person (GST transfers). In addition to any US estate tax or gift tax applicable to the transfer, US GST tax is imposed at a flat 40% rate on cumulative GST transfers above the basic exclusion (GST exemption) amount of $10,000,000, as adjusted annually for inflation from 2010 ($11,400,000 in 2019). US GST tax is due by April 15 of the year following the year in which the GST transfer was made or, in the case of GST transfers taking effect upon the donor’s death, on the due date of the US estate tax return in respect of the donor’s estate.
Property included in a decedent’s estate will qualify for a basis adjustment (commonly referred to a basis step-up, although the adjustment can be downward) to the property’s date of death (or alternate valuation date) value, for subsequent capital gains tax purposes.
Are tax reliefs available on gifts (either during the donor’s lifetime or on death) to a spouse, civil partner, or to any other relation, or of particular kinds of assets (e.g. business or agricultural assets), and how do any such reliefs apply?
All outright transfers by gift or bequest to a US citizen spouse qualify for the unlimited marital deduction and are not subject to gift or estate tax. Transfers in trust during lifetime or at death to a US citizen spouse will qualify for the unlimited marital deduction if during the spouse’s lifetime the trust (the ‘Marital Trust’) (1) is for the sole and exclusive benefit of the spouse; (2) no distributions from the trust may be made to any other person; and (3) all of the net income of the trust is required to be paid at least annually to the spouse. Likewise, property passing in the form of a life estate to a spouse in which some or all of the income is payable to the spouse but over which the spouse is granted a testamentary general power of appointment, will qualify for the unlimited marital deduction. The marital deduction is designed to defer the imposition of any transfer tax otherwise due on the transfer until the later death of the spouse.
No distinction is made between transfers to an opposite-sex spouse and transfers to a same-sex spouse.
No marital deduction is available with respect to a transfer outright to or in trust for a spouse who is not a US citizen unless the transfer is made by the donor spouse (or by the donee non-citizen spouse following receipt thereof) to a Qualified Domestic Trust (QDOT) containing statutorily-mandated provisions designed to ensure that any transfer tax otherwise due on the transfer will be paid eventually to the US. A QDOT must be maintained under the laws of a US state or the District of Columbia and the governing instrument thereof must be governed by the laws of a US state or the District of Columbia. Generally, a bank or trust company organized within the US must act as a Trustee, and QDOTs over a certain size must provide for the filing of a bond with the US Treasury. In other respects, a QDOT must contain the provisions required above for a Marital Trust. Distributions of principal from a QDOT to the noncitizen spouse will attract US estate tax at the donor spouse’s estate tax bracket. Relief from the QDOT requirements may be available if the spouse becomes a US citizen and meets certain residency requirements.
Do the tax laws encourage gifts (either during the donor’s lifetime or on death) to a charity, public foundation or similar entity, and how do the relevant tax rules apply?
Yes, US tax law encourages gifts to charity both during a donor’s lifetime and at death. Charities that receive the bulk of their support from the public (public charities) are completely exempt from US income taxation and all donations made to them are generally tax deductible to the donor, within certain limits. Private foundations usually receive all or most of their support from a limited universe of donors. Private foundations are also exempt from US income taxation, but they are subject to strict scrutiny by the Internal Revenue Service (IRS) and are subject to many regulatory provisions with which they must meticulously comply. The US imposes limitations on how much of a charitable contribution may be deducted against a taxpayer’s adjusted gross income (AGI). For tax years beginning after December 31, 2017, if all gifts made to a public charity are solely of cash, then such gifts are subject to a 60% limit, meaning that a donor’s deduction for the gift of the cash cannot exceed 60% of the donor’s AGI for the year of the gift. Otherwise, gifts of cash to a public charity (if made along with gifts of other property to charity) are subject to a 50% limitation; gifts of long-term capital gain property to a public charity, and gifts of cash to a private foundation, are subject to a 30% limit; and gifts of long-term capital gain property to a private foundation are subject to a 20% limit. Gifts of ordinary income property to a public charity or private foundation are limited to the lesser of the basis in such property or the AGI limitation available for cash gifts to such organization. Bequests of property taking effect at death to a public charity or to a private foundation, regardless of the character of the property, qualify for an unlimited charitable estate tax deduction.
How is real property situated in the jurisdiction taxed, in particular where it is owned by an individual who has no connection with the jurisdiction other than ownership of property there?
Real property taxes are not imposed at the federal level. In the US, taxes on real property are imposed at the state or local level and the tax rates of the states and local jurisdictions vary significantly. State and local governments levy taxes on real property situated within their jurisdictions, regardless of the citizenship of the owner. Property tax is generally determined by the property tax rate and the tax base. The tax base is determined by the assessed value of the property and assessment ratio. The methods for assessing property tax rates vary from jurisdiction to jurisdiction.
A property owner who has no connection with the jurisdiction other than ownership of property there should be mindful of the Foreign Investment in Real Property Tax Act (FIRPTA), which authorizes the US to tax nonresidents on dispositions of US real property interests. A disposition includes, but is not limited to, a sale or exchange, liquidation, redemption, gift or transfer. Persons purchasing US property interests from nonresidents are required to withhold 15% of the amount realized on the disposition. If the purchaser fails to withhold, the purchaser may be liable for the tax.
Are taxes other than those described above imposed on individuals and, if so, how do they apply?
In addition to the taxes described above, a number of states also impose an income tax on state residents. State income taxes are levied by many, but not all, of the states, as well as some local jurisdictions, and the rates vary greatly. For tax years beginning after December 31, 2017, individual taxpayers may elect to deduct state and local sales, income, or property taxes up to a limit of $10,000 ($5,000 for a married taxpayer filing a separate return). Such taxes in excess of those limits are not deductible for US income tax computation.
Sales and use taxes are other taxes imposed on individuals, generally at the state and/or local level. Sales and use tax rates of the states and local jurisdictions vary widely. Excise taxes, also known as luxury taxes, can be imposed at the state and federal level. US excise taxes are imposed on the purchase of heavy tires, gasoline, beer and liquor, cigarettes, airplane tickets and fishing equipment.
Is there an advantageous tax regime for individuals who have recently arrived in or are only partially connected with the jurisdiction?
All individuals taxed as US Persons are subject to the same income taxes. Nonresidents are not subject to income tax on most capital gains or on interest on bank deposits. As noted above, individuals who are not US citizens and are not considered domiciled in the US (separate from the substantial presence test for income taxation) are not subject to gift, estate, or GST tax on non-US property.
What steps might an individual be advised to consider before establishing residence in (or becoming otherwise connected for tax purposes with) the jurisdiction?
An individual should consider contributing assets to a foreign trust prior to entering the US. If done more than 5 years prior to becoming a US Person, the trust assets in most cases will not be subject to US income taxation. If an individual is very wealthy (more than $10 million of liquid assets), the individual may want to consider investing through a private placement life insurance policy, which is not subject to US income tax. If the individual is moving to a US state that imposes an income tax, the individual may want to establish a trust in a US state that does not impose income tax to avoid state income tax on those assets.
What are the main rules of succession, and what are the scope and effect of any rules of forced heirship?
Generally speaking, an individual is free to choose the beneficiaries of his or her estate by executing a Will (or Will substitute) detailing his or her wishes. However, most separate property states have elective share statutes that prohibit the disinheritance of a spouse, instead requiring that some portion of a person’s estate (usually about one-third) pass to his or her surviving spouse. Louisiana is the only state with forced heirship, requiring that some portion of a person’s estate is left to his or her children if such children are under age 24 or permanently incapable of taking care of their persons. (In Louisiana, the forced portion is typically one-fourth of the estate if there is only one forced heir, and one-half of the estate if there are two or more forced heirs. However, the fraction may be smaller in the situation where the testator has five or more children and only one or two of them are under age 24, or otherwise forced heirs, as well as in certain instances where disabled grandchildren are forced heirs.) If an individual dies without a Will, the distribution of his or her estate will be subject to the intestacy laws of the state of his or her residence. Each state has its own set of intestacy laws, but the surviving spouse and children are usually favoured.
Is there a special regime for matrimonial property or the property of a civil partnership, and how does that regime affect succession?
Under the US tax system, there are certain differences afforded to married couples.
With respect to income tax, a married couple who files jointly sometimes may pay more than they would as two single people. On the other hand, when one spouse earns all or most of the income, the couple often receives a ‘marriage bonus’, paying less in income taxes for their joint income than they would individually. A married couple also receives a standard deduction that is twice as high as the deduction for a single person. The capital gains tax exemption on the sale of a primary residence is $500,000 for a married couple as opposed to $250,000 for a single person. Spouses can also roll over a traditional or Roth IRA received from a spouse into a spousal rollover IRA.
With respect to succession, the rules for matrimonial property vary from state to state. In a community property state, the union is viewed as a partnership in which each spouse contributes labour. Each spouse automatically has a 50% interest in all community property, regardless of which spouse acquired the community property. Community property is generally defined as all property acquired during marriage that is not established to be separate property. Separate property is property owned solely by one spouse or the other.
In community property states, each spouse is taxed on 50% of the total community property regardless of which spouse acquired the income. Each spouse is taxed on 100% of his or her separate property.
For federal tax purposes, a taxpayer’s rights and interests in property are determined under the laws of the taxpayer’s state of domicile. In a community property state, each spouse has the right to dispose of his or her share of community property in whatever way he or she desires, including giving his or her half of the community property to someone other than the surviving spouse.
In non-community property states, ownership is determined by the name on title. Most non-community property states have right of election statutes, which prevent a decedent from disinheriting his or her spouse. For example, in New York, a decedent must leave his or her spouse the greater of $50,000 or one-third of his or her estate. If the decedent does not provide in his or her Will that the spouse receive his or her ‘elective share’, the spouse can elect against the Will. In some states, the elective share is dependent on the number of years the parties were married.
Generally, a spouse’s rights and interests in the other spouse’s estate are determined under the laws of the decedent’s domicile. In non-community property states, the elective share of a surviving spouse cannot be curtailed without the consent of the surviving spouse.
What factors cause the succession law of the jurisdiction to apply on the death of an individual?
Two main factors will determine which state’s succession or intestacy laws control the disposition of a decedent’s estate: (1) the property classification, or type, of each item of property, and (2) the state of a person’s domicile at the time of death.
There are generally three types of property: (1) real estate; (2) intangible personal property (such as cash and stock); and (3) tangible personal property.
Domicile is the geographic location of a person’s permanent legal residence. A person’s domicile is the place he or she intends to use as his or her dwelling for an indefinite period of time. It is the place to which the person intends to return. A person’s intention regarding domicile is determined by his or her actions, such as where the person votes and where he or she pays state income taxes. An individual can only have one domicile.
The law of a person’s domicile generally determines the disposition of intangible and tangible personal property, even if it is located in different states. The disposition of real estate, however, is controlled by the state in which it is located. Accordingly, ancillary probate or administration will be required if a decedent dies owning real property outside of his or her state of domicile.
How does the jurisdiction deal with conflict between its succession laws and those of another jurisdiction with which the deceased was connected or in which the deceased owned property?
The doctrine of renvoi is a legal doctrine which applies when a court is faced with a conflict of law and must consider the law of another jurisdiction. The doctrine of renvoi is the process by which the court adopts the rules of a foreign jurisdiction with respect to any conflict of law that arises.
The US does not accept the doctrine of renvoi. The US deals with the choice of law in matters of inheritance based upon location and domicile as discussed above. For real property, the law of the location of real property governs. For intangible and tangible property, the law of the decedent’s domicile applies.
Some states have a comprehensive choice of law statute that considers issues such as revocation and interpretation of testamentary dispositions and the exercise of powers of appointment. Principles of conflict of laws provide guidelines to determine whether a court of the forum jurisdiction will apply its own laws or the laws of another jurisdiction to a dispute. The choice of law question is different from the question of whether a court has jurisdiction and requires a determination of what law to apply to a given issue.
States without choice of law statutes apply a reasonableness or fundamental fairness analysis by analysing contacts, such as length of residence, physical location of assets, domicile and intention. The traditional conflict of law approach turns to the law of the domicile to determine succession to immoveable property and tangible personal property and the law of the situs of real property. A choice of law analysis requires the court to weigh and balance the policies of the competing jurisdictions and the interests that those jurisdictions have in the application of their respective laws at issue.
Another issue that arises when a decedent dies owning foreign property is the risk of double taxation. As noted above, when a US citizen dies owning property in a foreign country, the property in the foreign country will be subject to US estate taxes. Estate tax treaties entered into between the US and 16 other – primarily developed – nations can ameliorate the effect of any such taxes.
In what circumstances should an individual make a Will, what are the consequences of dying without having made a Will, and what are the formal requirements for making a Will?
There are two main reasons an individual should make a Will: (1) to name a guardian of any minor child; and (2) if he or she (a) has assets in his or her sole name, and (b) would like to direct the disposition of those assets at his or her death. The statutory requirements for executing a valid Will differ by state, but a person generally must be over age 18, of sound mind and under no apparent duress or undue influence. If an individual dies without a Will, his or her assets will pass pursuant to the intestacy laws of the state in which the property is located, regardless of the decedent’s wishes. In addition, the process of administering an estate of a decedent who died without a Will is a more arduous process than the administration of a testate estate. If a non-resident owns US-situs real property outright, his or her foreign Will that dictates the disposition of the real property might not be honoured by a court in the state where the property is located (or the probate thereof may be complicated by the existence of the foreign Will, causing delay). As such, the non-resident may wish to consider executing an American Will to dispose of such property at death to ensure that it is distributed in accordance with his or her wishes. However, see the answer to question 5 above, for a discussion of the estate tax consequences of a nonresident directly owning US-situs property.
How is the estate of a deceased individual administered and who is responsible for collecting in assets, paying debts, and distributing to beneficiaries?
The estate of a deceased individual is administered through a process known as probate. Probate is a court-supervised process through which a decedent’s assets are collected, debts are paid, and remaining property is distributed to beneficiaries according to the terms of the decedent’s Will, or, if the decedent died without a Will, according to the intestacy statute of the state or states in which probate occurs. A court-appointed individual, called an executor or administrator or personal representative, is responsible for administering the decedent’s estate. Typically, a decedent’s Will names the executor, while an administrator is chosen by the court where no Will exists or where no executor is named in the Will.
Probate occurs in the state where the decedent was domiciled at death, as well as in any states in which the decedent owned real or tangible personal property. Generally, the law of the state where the decedent was domiciled at death governs the disposition of intangible property. The disposition of real or tangible personal property, however, is governed by the law of the state in which such property is located. Where such property is located in multiple states, ancillary probate may be required.
Do the laws of your jurisdiction allow individuals to create trusts, private foundations, family companies, family partnerships or similar structures to hold, administer and regulate succession to private family wealth and, if so, which structures are most commonly or advantageously used?
Yes, US tax law and the laws of the various states and other jurisdictions within the US recognize a wide variety of trusts, both revocable and irrevocable, private foundations, both operating and grant-making, and family limited liability companies (FLLCs) and family limited liability partnerships (FLPs). Generally, wealth transfer planning for US clients will involve use of some or all of these structures.
How is any such structure constituted, what are the main rules that govern it, and what requirements are there for registration with or disclosure to any authority or regulator?
Domestic trust structures, including trusts with a charitable component, are created pursuant to the governing law of a state or other jurisdiction of the US. The various states compete against each other to provide favourable trust law (including the extension or repeal of the rule against perpetuities, the limiting of beneficiaries’ rights to receive information on trust assets, and the creation of favourable laws relating to trustees and protectors) and tax law to attract trust business. Generally, the creation of a domestic trust does not require the filing of the trust instrument with any governing authority or regulator, and the trust may remain private. If a US gift tax return is filed to report a gift or sale to a trust, it is common to include a copy of the trust instrument with the return. US gift tax returns are confidential and not subject to public exhibition. US income tax returns that may be required for domestic trusts are likewise confidential.
As in the case of trusts, domestic private foundations, FLPs and FLLCs are created pursuant to the governing law of a state or other jurisdiction of the US; and the various states compete against each other to provide favourable partnership and corporate law applicable to these entities. Private foundations may be formed as a trust or as a corporation (the latter provides additional flexibility and less court oversight), and in general, the creation of a private foundation or FLP or FLLC requires the filing of a certificate of incorporation or of limited partnership with the office of the Secretary of State of the chosen state. Annual tax reporting must be made to the IRS and, depending upon the chosen state, may be required to be made to the state. Annual information returns filed by a private foundation with the IRS are public documents. Annual income tax returns of FLPs and FLLCs are confidential.
What information is required to be made available to the public regarding such structures and the ultimate beneficial ownership or control of such structures or of private assets generally?
Generally, the creation of a domestic trust does not require the filing of the trust instrument with any governing authority or regulator, and the trust may remain private, subject to a few exceptions. If a US gift tax return is filed to report a gift or sale to a trust, it is common to include a copy of the trust instrument with the return. US gift tax returns are confidential and not subject to public dissemination by the IRS. US income tax returns that may be required for domestic trusts are likewise confidential. Similarly, annual income tax returns of FLPs and FLLCs are confidential. However, during the administration of a testamentary trust, the trustee may be required to file information pertaining to the trust’s assets on the state death tax return. The extent to which such returns are available to the public may vary from state to state.
Third parties that are associated with a domestic trust, such as banks, brokerage firms and insurance companies, can demand to see the trust document. The Trustee can take steps to protect the beneficiaries’ privacy by furnishing a certification of trust, along with relevant excerpts from the trust document instead of the trust itself. The contents of the certification of trust vary depending on the state.
The beneficial owner of residential real property held in a domestic trust or FLLC also can remain confidential, subject to a few exceptions. Generally, the documents that are available to the public that pertain to the transfer of the residential real property to the domestic trust or FLLC include only the name of the legal entity. However, in certain regions throughout the U.S. (notably cities and counties with high-value residential real property), the identity of the beneficial owner of residential real property must be disclosed upon the purchase by an FLLC of residential real property where the total purchase price exceeds $300,000, the purchase of the residential real property is made without obtaining financing from a financial institution and any portion of the purchase price is made using currency, cashier’s check, certified check, traveller’s check, personal check, business check, money order in any form, funds transfer, or virtual currency. (The disclosure requirements do not apply to purchases through a trust.)
Private foundations are required to file annual information returns with the IRS. These are publicly available documents. However, the names and addresses of contributors are not required on the return and can remain confidential.
How are such structures and their settlors, founders, trustees, directors and beneficiaries treated for tax purposes?
Domestic trusts are generally either ‘grantor trusts’ or ‘non-grantor trusts.’ Grantor trusts are trusts that are disregarded for income tax purposes, so that all items of income, gain, expense and loss are attributable to the grantor thereof and not to the trust. To be a grantor trust, the trust must contain certain IRS-approved provisions. Grantor trust status may confer beneficial treatment upon a trust in that all gains in the trust are taxed to the grantor and not to the trust, thereby allowing the trust to grow tax-free while it remains a grantor trust. There are ways in which grantor trust status may be turned off, so that future earnings are taxed to the trust. Grantor trust status ends upon the death of the grantor. Non-grantor trusts are taxed on their income and gains. Distributions from a non-grantor trust to a beneficiary generally carry out distributable net income (DNI) to the beneficiary. Because trust tax brackets are more compressed than those for individuals, carrying out DNI to a beneficiary may result in a lower tax than if the income were taxed at the trust level.
Generally, private foundations are required annually to pay out an amount equal to at least 5% of their assets for charitable purposes, which includes, for grant-making foundations, grants to public charities. In addition, private grant-making foundations must pay an excise tax of 2% of net investment income; that tax may be reduced by 1% if the annual payment for charitable purposes is increased by at least 1%.
Single member LLCs are not required to file US income tax returns; their income is taxed to their member. Multimember FLPs and LLCs are required to file US income tax returns and are subject to US income tax on their earnings; generally their income is passed out to their partners or members.For tax years beginning after December 31, 2017, certain non-corporate taxpayers, including multimember FLPs and LLCs, may deduct up to 20% of their "qualified business income" (generally, domestic business income from a "qualified trade or business") subject to certain limitations in calculating their taxable income.
Are foreign trusts, private foundations etc recognised?
Foreign trusts are recognized but are disfavoured. There is a heavy reporting burden for US Persons who establish or are beneficiaries of a foreign trust. Foreign private foundations are recognized, but are taxed differently depending on whether they are charitable foundations or are privately-owned.
How are such foreign structures and their settlors, founders, trustees, directors and beneficiaries treated for tax purposes?
The US Person settlor of a foreign trust is taxed on all of the trust’s income and capital gains. For foreign trusts that are not taxed to the settlor, income and capital gains must be distributed each year (and are subject to tax if distributed to a US Person). Any income and capital gains not so distributed accumulate and are subject to punitive tax and interest charges if ultimately distributed to US Persons. Income earned by certain foreign entities held in a foreign trust are taxed currently to the US beneficiaries, even if trust income is not itself taxed currently to US Persons.
If a foreign private foundation is considered a charitable entity, it is generally not subject to US taxation. If it is considered privately-owned by a US Person, a US Person owner may be taxed on the private foundation’s income as though the foundation were a corporation. No income tax charitable deduction is permitted for contributions by a US Person to a foreign private foundation. A charitable contribution to a foreign private foundation is deductible against estate and gift taxes in certain circumstances.
To what extent can trusts, private foundations etc be used to shelter assets from the creditors of a settlor or beneficiary of the structure?
Irrevocable trusts set up by a settlor for third parties are generally protected against the creditors of the settlor if the settlor no longer owns the property and no longer controls the beneficial enjoyment thereof. Upon transfer into the trust, the settlor has no power to use the trust assets. In the absence of fraud, the settlor’s creditors generally cannot reach the assets in an irrevocable trust if the settlor gave up complete control.
A self-settled spendthrift trust is a type of irrevocable trust that provides the settlor with protection from creditors but does not require the settlor to give up total control. Under a self-settled spendthrift trust, the settlor can be a beneficiary and retain certain controls, such as the ability to direct investments. Once an asset is transferred to the trust, the settlor’s creditors have a limited time period to challenge the transfer and assert a claim against the asset. If the creditor fails to do so, the asset is protected. This type of trust is currently permitted in a number of states.
Irrevocable trusts can also provide asset protection for beneficiaries. A trust agreement may provide that the beneficiary’s interest is purely discretionary and can include a spendthrift provision that prevents creditors of the beneficiary from making a claim against the beneficiary’s interest in the trust. However, once trust assets are distributed to the beneficiary, the assets are subject to the claims of the beneficiary’s creditors.
What provision can be made to hold and manage assets for minor children and grandchildren?
Assets can be held and managed for minor children and/or grandchildren by a custodian or a Trustee.
Under the Uniform Transfers to Minors Act (UTMA), a person can open a custodial bank account for the benefit of a minor child. The assets in an UTMA account are managed by a designated custodian and distributed to the child when he or she attains the age of 18 or 21, depending on the state and the donor’s preference. A UTMA account for a child that is under the age of 19 or a full-time student under the age of 24 and holds unearned income that is in excess of $2,100 is taxed at the ordinary and capital gains rates applicable to trusts and estates.
Another option is to transfer assets in trust for the benefit of a minor child or grandchild. Most standard trust arrangements will work, but some are more tax advantaged than others. For example, certain trusts allow the donor to make gifts that qualify for the annual exclusion. One type of trust that qualifies for the annual exclusion requires that each beneficiary receive (a) notification of any contribution made to the trust, and (b) is given the opportunity to withdraw his or her share of the contribution. Another type of trust gives the minor child the right to withdraw the assets of the trust upon attaining the age of 21. Under either trust structure, if the child chooses not to exercise his or her right to withdraw the assets within a specified period of time, the assets can remain in trust until some later date (designated by the settlor of the trust). Yet another type of tax-advantaged trust can make use of the settlor’s GST exemption thereby sheltering assets from transfer tax for multiple generations. The taxation of income generated by assets held in trust varies based on the type of trust and the way in which it is structured.
Are individuals advised to create documents or take other steps in view of their possible mental incapacity and, if so, what are the main features of the advisable arrangements?
Yes. Individuals are advised to execute documents to deal with both medical and financial decisions in the event of mental or physical incapacity. The names and forms of these documents differ by state, but the concepts are the same. The first document, often referred to as a ‘Living Will’, allows an individual to provide specific instructions about his or her medical treatment in the event of incapacity; for example, an individual can direct that he or she does not wish to have a feeding tube to be kept alive. The second document, often referred to as a ‘Health Care Proxy’, allows an individual to appoint someone to make medical decisions on his or her behalf (to the extent not already provided for in the Living Will) if he or she is unable to do. Finally, a durable power of attorney is recommended to name an agent to act on a person’s behalf with respect to his or her financial matters. Some states require that this document be effective immediately, but in most states there is an option to have the document become effective upon the principal’s incapacity. Under either scenario, the durable power of attorney will remain effective through the principal’s incapacity and terminates at his or her death.
What forms of charitable trust, charitable company, or philanthropic foundation are commonly established by individuals, and how is this done?
Individuals in the US commonly establish private grant-making foundations, private operating foundations, public charities, and supporting organizations, which are tax-exempt charitable organizations typically structured as either charitable trusts or nonprofit corporations. Individuals may also establish split-interest trusts, which are trust arrangements that allow individuals to make charitable contributions of property, while retaining (or transferring to non-charitable beneficiaries) an interest in the property transferred.
Private grant-making foundations are nonprofit organizations primarily funded by one family or business. The private foundation’s endowment is invested to generate returns, and the foundation uses its endowment to fund its operations and to make grants to other charitable organizations.
Private operating foundations are private foundations that directly conduct charitable activities. Examples of private operating foundations include certain museums, zoos, and libraries that do not receive substantial support from donations by the general public.
Public charities are publically-supported organizations, meaning that they receive significant support in the form of contributions from government units and/or the general public. Public charities make grants to other charitable organizations and directly provide charitable services.
Supporting organizations are charitable organizations that support one or more public charities by providing them with financial resources and/or conducting charitable activities that the public charities would otherwise have to undertake themselves.
To establish a private grant-making foundation, private operating foundation, supporting organization, or public charity, an individual must first establish a legally-recognized trust or corporation in the state in which the charitable entity will be located. Then, to receive federal tax-exempt status, the individual must apply for recognition of exemption from the IRS.
Split-interest trusts are trust arrangements in which an individual retains (or transfers to non-charitable beneficiaries) either an income or remainder interest in the trust property, while passing the other trust interest to a charitable organization. The individual may receive income, gift and estate tax charitable deductions for the present value of the property that is expected to pass to charity. In order to establish a split-interest trust, an individual need only create a legally valid trust arrangement, but there are strict rules regarding the language required in the Trust Deed.
What important legislative changes do you anticipate so far as they affect your advice to private clients?
On December 22, 2017, President Trump signed into law H.R. 1, a Congressional bill informally known as the “Tax Cuts and Jobs Act” (the Act), which represented the most significant overhaul to the US tax system in over 30 years. Generally, the provisions of the Act took effect for tax years beginning after December 31, 2017. Among other changes, the Act modified the individual income tax brackets, doubled the amount of the exclusions from gift, estate and generation-skipping transfer taxes, and limits individual income tax deductions for state and local taxes. These changes are effective until January 1, 2026, at which time the Act provides for a return to prior law. The above answers reflect the current state of the law under the Act.
Beginning January 3, 2019, the House of Representatives (the lower house of Congress) will be under the control of the Democratic Party; the Senate remains in the hands of the Republican Party. It is unlikely that significant further tax cuts will be enacted during that period of divided government, which should extend at least until January 3, 2021.